Mutual Fund investing: A note for beginners

Read a good post here and and sharing some of the thoughts therein for new investors in mutual funds

The contents of this post are subject to the following assumptions:

• The investment would be used for financial independence later in life and that there is no other goal in the horizon.
• Basic fortifications like emergency fund, life insurance (if there are dependents), health insurance (for parents and self) are in place.
• The young earner understands the importance of equity exposure

There are several articles on what a mutual fund is, different types of mutual funds, how to invest in direct mutual funds etc. So I choose not to reinvent the wheel here.

Direct Equity vs. Equity Mutual Funds

Personally I think there is absolutely no need for an individual ( young or old) to invest in direct equity. Equity mutual funds if held onto for a long enough period of time, is  more than likely to beat inflation and even give you a little extra after expenses.

Perhaps one can hasten financial independence with direct equity exposure but such a path is fraught with peril.

That said, in my uninformed opinion,  gradually accumulating and holding solid large cap companies instead of chasing multi-baggers is a decent way to ‘create wealth’. 

Naturally one must learn how to choose a solid business before taking the plunge. Since this would take a while, I suggest the following:

1) Start a SIP in a single large and mid-cap fund 

2) If you need to save tax, use an ELSS fund - tax saving mutual fund.  Just use ELSS + EPF + Term insurance premium (if applicable) for tax savings.

Personally I dont do SIP in ELSS funds (because getting rid of a poor performer would seem like forever). If you are okay with it, go for it. Just be sure to discontinue the SIP (and switch to another fund) after your EPF exceeds the 80C limit.

3) If you don’t care for direct equity, then that is all that you need to do!

• As and when you get extra cash, buy more units Either in the ELSS fund (if you have not exhausted 80C limits) or in the large and mid-cap fund.
• Do not monitor the value of your investment every day! Monitor only how much you invest 

4) If you wish to get into direct equity, then obviously you must learn. There are many useful resources. I prefer:
tyroinvestor.com and stableinvestor.com  and the resources mentioned in them.

These are written by passionate youngsters who are learning on the fly and do not hold anything back. I would prefer to learn from them any day compared to an ‘expert’ who runs a business.

We have a lifetime to learn and invest in equities. So there is no flaming hurry. Get the mutual fund investment going, learn in leisure and invest when you feel comfortable and ready.

DIY vs. Professional Help

While a young earner is best suited for DIY (do it yourself), taking professional help and then learning in one owns pace is also a fantastic idea.
Young earners are often under a lot of stress. So professional help could help calm nerves and enable them to focus on their career better.

I would recommend starting a relationship with a fee-only planner.

The learning cannot be skipped!

Regular plans vs. Direct plans

If you employ the services of an IFA or use online distribution portals, think of the trail commission that you can save in direct plans as a fee for service or value adds.

If the features of an online portal are effectively used, then there is no need to lose sleep over being in regular plans.

DIY investing need not be 100% DIY.  Someone who uses an intermediary for investments but handles other aspects of goal-based investing on their own (monitoring, tracking investments, rebalancing  etc.) are also DIY investors.

Yes, I am an investor in direct plans and promote them every time I get an excuse. 

More than time, effort etc. direct plan investing requires confidence. If you think you can confidently pick funds and manage your folio, go direct.
Else
1) either seek counsel from a fee-only planner and go direct or
2) go regular and be happy with your choice.

At the cost of repeating myself, either way the learning cannot be skipped!

Trust the planner or IFA. Do not post their recommendations in forums for ‘double-checking’. 

Finally,

• Never ever buy mutual funds from a bank.
• Do not buy an NFO because  it is an NFO.
• Do not buy/sell a fund because others are talking highly/lowly about it.
• Do not clutter your portfolio. Choose a minimalist portfolio.

To sum it up, choose ONE fund, invest with discipline. Do not look the folio value for at least 5 years. In the meanwhile learn about stock investing, if you must. Seek professional advice and not free lunch if you lack confidence.

The 10 commandments of investing

"The 10 commandments of investing" written by Prof. Parag Rijwani Thought it would be of interest to those who have not seen it before (he posted it a few months backin a FB Post)
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This is what I wrote to a past student sometime back. He has recently started his career and is posted abroad on company’s projects. The 10 commandments!

1. Create an emergency fund that can meet your expenses if you remain unemployed for 5-6 months. Part of this should be kept in savings bank account and remaining in an e-fixed deposit that is done through net banking. These can be withdrawn anytime without any charges /penalties. 

2. Take a TERM INSURANCE for yourself as soon as you have a financial liability to meet. Comprehend that if you don’t have financial liability, YOU don’t need insurance. NEVER buy any other life insurance product because one should not mix two spirits. Cheers!

3. Increase the Term Insurance cover by taking newer/additional policies as and when you financial liabilities/future goals emerge. Like after getting married, having kid(s), parents getting retired, borrowing loan(s) etc. Always buy it online by disclosing ALL details CORRECTLY. Hiding anything may defeat the purpose resulting into claim rejection i.e. if you enjoy Chivas Regal, disclose it!

4. Take a medical insurance immediately! (even if you have a cover from your employer). Take a family floater that covers your present and future dependents (if any). Search for a product called Max Bupa. Read more on this before buying. 

5. Equity (read again, ONLY equity) can give you inflation beating returns (real returns) in long run. So stay invested in equity till the time you need money in your life. Invest in direct equity (i.e. stocks) ONLY if you have time and skill to spot next Wipro, HDFC etc. I know a few who read 50 annual reports and invest in 4-5. If you can’t do this and/or can’t spare time, share 2-3% with Mutual Fund manager. 2-3 mutual fund schemes are sufficient to make a GOOD portfolio. The more NOT the merrier!

6. Debt is a very crucial part of your portfolio. Instruments like PF, PPF, Bonds, FDs etc. are few to list. Most of them are tax inefficient and illiquid. I am lucky to have a decent contribution to PF so I have conveniently and completely PPF. Find out what suits you. 

7. Do NOT buy Real Estate and Gold beyond your consumption needs i.e. they do not find a place in you ‘investment’ portfolio. If my father had not bought the present house that I reside in, I had stayed in rented house ALL my life. 

8. Use of credit card should be prudent. I use credit card for virtually EVERY expense that I incur. But in the past decade I have NEVER defaulted on paying the full bill before the due date. CIBIL score (google it if you hear this for the first time). 

9. Learn to live a frugal lifestyle and simple eating habits. Do not overboard on lavishing habits. Do NOT buy things that you really don’t need. Invest in your health. Invest at least 40% of your take home salary every month. Investing is like a habit, cultivate it!

10. Spare time to learn personal finances. No agent can make YOU rich. You must take charge of your finances ASAP. Read about personal financial planning (books, blogs, articles but don’t get carried away) and talk about it with people who can add to your knowledge. There is EQUAL amount of financial PORN out there!

Abhi ke liye itna kaafi hai, shayad!

Five general rules for investing money wisely

At its core, investing money wisely comes down to a handful of behaviors that harness several powerful forces to build wealth for your family.  You "win" the game, so to speak, when your passive income reaches a point where it, by itself, gives you financial independence.  This means that the finish line for every investor is different because everyone has different lifestyle goals, objectives, and plans.

I have five general rules for investing money wisely - things that, if followed, can make the journey to fiscal affluence a lot easier.  Keep them in mind when thinking about how to handle your own financial concerns, taking what works for you. Some people truly want nothing more than a few acres in view of a mountain, a log cabin, a hunting rifle, a faithful dog, and a good book to read on the porch.  Others want fast cars, Ocean-side villas, expensive watches, and trust funds stuffed with so many stocks, bonds, mutual funds, and real estate properties, their great-grandchildren won't have to worry about anything.

1. Investing Money Wisely Means Never Owning Something You Don't Understand

If there is one rule that could save tremendous amounts of financial heartache it would be this: Do not buy or hold anything you can't explain to a kindergartener in three sentences or less: How it makes its money, what its potential pitfalls are, and how that money finds its way into your hands.  This sounds so simple - and it is - but few people seem to follow it.

 The moment a bull market starts raging somewhere, otherwise perfectly reasonable people who have enough common sense not to walk out into the rain without an umbrella suddenly get it in their heads they should be buying collateralized debt obligations, even though they couldn't tell you what they are, or giving up their safe cash deposits and swapping them for auction rate securities, even though they can't explain how they work.

Do you know the difference between a share of stock and a master limited partnership unit?  No?  Then don't buy MLPs through your broker.  They look like stocks, trade like stocks, but are most definitely not stocks.  You can be in for an unpleasant tax surprise if you start collecting them without knowing what you're doing.  Do you know how preferred stock differs from common stock and corporate bonds?  No?  Then don't buy them.  The same goes for everything from convertible shares to REITs.  There's plenty of time to learn about these securities and you can always buy them tomorrow.  Jumping in before you are ready, well-informed, and aware of the dangers is like a non-swimmer deciding his first foray into the pool should be from the the high dive board of an Olympic facility.  It's probably not going to end well and if it does, it's luck, not skill.

2. Investing Money Wisely Means Protecting Yourself Against the Downside By Proactively Managing Risk

Risk is ever-present when managing your money and investing wisely requires you to respect it while simultaneously reducing it.  If you don't, you can wipe out years, maybe even decades or a lifetime, of savings; savings for which you swapped part of your life expectancy (quite literally - you sold hours of your life in exchange for that cash; hours you could have been sitting on a beach, writing a novel, learning to paint, sailing off the coast of Florida, or pursuing your favorite hobby).  There are the three types of investment risk, there's liquidity risk, there's inflation risk, there's market risk, counter-party risk, fraud risk.  On and on it goes.  This is one of the reasons it is so important to focus not on absolute returns, but on risk-adjusted returns; to actively, constantly, strive to reduce risk.

For most investors, dollar cost averaging into a diversified portfolio over many decades is, statistically, the most successful way to drastically reduce risks of all kind.  Couple this with large cash reserves to provide a cushion in the event of a job loss, recession, stock market closure or collapse, natural disaster, or other non-expected situations and you are on the right track.  This might sound counter-intuitive but rich investors are actually obsessed with maintaining high cash balances.  Of the 115,610,216 households in the United States, an estimated 1,821,745 have investment portfolios worth more than $3,000,000 and much of this money is parked in liquid greenbacks.  How do you think the wealthy are able to buy up assets on the cheap when everything goes south?  Perhaps nobody embodies this concept better than billionaire investor Warren Buffett.  His holding company, Berkshire Hathaway, has an estimated $60 billion in cash and cash equivalents sitting on the balance sheet.  He piles up money, sometimes for years on end - there was a period spanning much of the 1980's, in fact, when he didn't buy a single stock at all - waiting for the right opportunity to pick up incredible enterprises that he then sits on for decades.

3. Investing Money Wisely Means Taking Advantage of the Power of Compound Interest as Early as Possible

Wise investing means harnessing the power of compound interest.  The younger you start, the easier it is to amass a jaw-dropping net worth.  A college student saving a mere $111 per paycheck, by way of example, could end up with $4,426,000.  This is one of the reasons it's so easy for the rich to get richer: When you set up a trust fund for your children or grandchildren, they get to benefit from a lifetime of compounding, watching their money grow while in elementary school.  Those extra years are extraordinary in terms of final outcomes.

Perhaps an actual mathematical example might help.  We'll use some time value of money formulas.  Imagine there are three people - Samuel, Abigail, and Daisy.

• Samuel begins life with no investments, doesn't save throughout his twenties and thirties, but starts making a lot of money by the time he is 45 at which point he promptly begins putting aside $5,000 a month.  Assuming average rates of return on his equities, he ends up with $3,436,500 before taxes by the time he retires.
• Abigail begins life with no investments but she was always keen on personal finance and money.  At 18 years old, she decides to put aside $100 a week.  She maintains this habit throughout her lifetime and never increased the amount by inflation, meaning it progressively became easier and easier to fund.  Assuming average rates of return on her equities, she ends up with $4,534,269 before taxes by the time she retires.
• Daisy is born and from the first breath she takes, her parents put aside $25 a week for her investments.  This routine is maintained throughout her entire life, and it is never increased with inflation.  Assuming average rates of return on her equities, she ends up with $6,361,819 by the time she retires.

If you want to know how to get rich, there's the secret: Either put a lot of money to work, let it work for a long period of time, or, ideally, both.

4. Investing Money Wisely Means Arranging Your Holdings and Behaving In a Way That Allows You To Minimize Taxes

Having seen how powerful compounding is in the last section, you realize that every dollar is worth a whole lot more future dollars if prudently managed.  The more you can save on taxes, the more money you have working for you.  Learn how to take advantage of deferred tax liabilities.  Figure out how to use a Roth IRA, which is the closest thing to a perfect tax shelter the poor and middle classes are likely to ever get.  Have your family structure its holdings so the stepped-up basis loophole can be taken advantage of upon death.  Utilize the asset placement technique to minimize tax payments.  Form family limited partnerships to transfer wealth using liquidity discounts to lower gift taxes.

Do not cheat on your taxes, do not get close to the edge of the lines, but definitely take advantage of all of the breaks Congress has given you under the law. Your elected representatives put them there for a reason and assumed you'd avail yourself of them so speak with your advisors to find out what you're missing.

5. Investing Money Wisely Means Controlling Your Expenses

Sometimes, fees can be worth it.  For certain high net worth individuals, especially with complex needs (say you worked for a Fortune 500 company and ended up accumulating a concentrated block of highly appreciated stock you need to liquidate in an orderly manner, while minimizing taxes and protecting against a sudden market collapse), a private bank or registered investment advisor charging a 1% or 2% fee can absolutely be worth his or her weight in gold, far exceeding the amount that would have been saved with the attempted do-it-yourself approach.  Structuring a portfolio using something like a charitable remainder trust alone can pay for itself in tax savings many, many times over.  Setting up a so-called QTIP trust that makes sure children from a first marriage aren't purposely or accidentally disinherited by a second (or fourth) spouse while the latter spouse is still provided for during the remainder of his or her life has value.  There are dozens of situations in which that fee about which everyone likes to complain is the best money you can spend, provided it is integrated into a broader service package.  Real estate developer?  You might get access to much better financing terms on your projects by being part of the private client group, the fee you pay on your trust and portfolio assets dwarfed by the interest savings on the debt side.  Your teenage son got in an accident, you're out of the country, and you need someone to bail him out of jail in the middle of the night?  Your white-shoe private wealth management firm might do it for you but a firm like Vanguard certainly wont.  That's the trade-off.  You have to look at the whole picture.  What are you getting?  Market returns aren't the only variable.  Service, risk reduction, access, expanded product offerings, and privacy assistance are all on the menu.

That said, for many small and medium-sized investors, this isn't a concern.  They are never going to have enough wealth, nor needs complex enough, to care about the added services and benefits.  There are no oil paintings to insure or background checks on nannies to perform.  In that sense, costs matter and the costs to which you want to pay the most attention probably include the mutual fund expense ratio.  For many, this means opting for something like a low-cost, passively managed index fund from a firm like the aforementioned Vanguard.  For others, it's going to be switching to a discount brokerage firm charging $10 or less per trade instead of a traditional bank that assesses a $150 commission on the same trade execution.